Is Dollar General the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Dollar General (NYSE: DG  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Dollar General.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 8.7% Fail
  1-Year Revenue Growth > 12% 10.5% Fail
Margins Gross Margin > 35% 32% Fail
  Net Margin > 15% 4.8% Fail
Balance Sheet Debt to Equity < 50% 81.1% Fail
  Current Ratio > 1.3 1.73 Pass
Opportunities Return on Equity > 15% 16.9% Pass
Valuation Normalized P/E < 20 21.09 Fail
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   2 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

With a score of 2, Dollar General doesn't make an impressive appearance. The discount retailer is in the right industry at the right time, but it still falls short on most of the measures you want to see in a perfect stock.

The dollar-store industry flourished during the recession, as cash-strapped consumers found their bargain prices and cozier store locations even more attractive than those of discount king Wal-Mart (NYSE: WMT  ) . But to many investors' surprise, even as the economy rebounds, dollar stores continue to thrive; shoppers have apparently stuck with them, rather than trading back up to higher-priced retailers.

That resilience has attracted takeover activity in the sector. Last month, Family Dollar (NYSE: FDO  ) got a bid from investor Nelson Peltz's Trian Fund Management to take the company private at a big premium to its then-current share price. That not only sent Family Dollar shares soaring, but also raised interest in Dollar General and Dollar Tree (Nasdaq: DLTR  ) as well. Earlier this month, 99 Cents Only Stores (NYSE: NCN  ) also received a buyout bid.

Historically, Dollar General's financials haven't stacked up well against most of its peers. It has more debt than Family Dollar, Dollar Tree, or 99 Cents Only. And although Dollar General has higher growth and returns on equity than 99 Cents Only, Family Dollar and Dollar Tree both trump Dollar General on ROE and gross margins.

But in its most recent earnings report, Dollar General posted strong earnings and a positive outlook, with plans to open 625 new stores this year. That could help it even if no buyer comes forward to snap up the discount retailer.

At this point, takeover speculation is so strong that it's dominating the stock's trading activity. Despite having some good potential, Dollar General has a long way to go before it looks like a perfect stock.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Add Dollar General to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Motley Fool Options has recommended a diagonal call position on Wal-Mart, which is a Motley Fool Inside Value and Motley Fool Global Gains recommendation. The Fool owns shares of Wal-Mart. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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